Dumb Money

by: Investment Pancake

Has anyone here ever met "dumb money?" I can't figure out who these people are even supposed to be.

But I do my level best to not do the things that I think they are supposedly doing, often with woefully mixed results.

How a 4-year old taught me the ropes.

It has got to be the most derisive playground insult that you can hurl at someone on Wall Street. Dumb money. It's worse than vocalizing the untoward virtues of another investor's mother, embellished with a derisive "and your sister, too." The funny thing is, I don't even know precisely who the "dumb money" is. Nobody's ever given me a business card with their name and the words "dumb money" printed underneath. I don't even know if these people actually exist in real life - but that doesn't stop me from being damn sure that I don't want to be one of them.

I may not be "smart" money... but could you at least call me "not exactly dumb" money? After all, I read quarterly reports. I listen in on the conference calls. I even go so far as to actively separate myself from the dumb money herds by playing contrarian investor. It feels so empowering to zig when the dumb money zags that it almost doesn't even matter to me whether I end up losing money in the process! I'm satisfied just as long as I lose my money in a different way than all the dumb money investors lost theirs.

Mind you, it's not that being "smart money" is necessarily any more profitable than being "dumb money". Just ask Eddie Lampert, David Einhorn, or Bruce Ackman how their day is going. My issue is that "smart money" sounds so enviably good. Call me shallow, but I secretly pine to wear a "smart money" pin on my lapel (I just don't want to endure the abysmal investment performance that goes with it).

Over the years, you've probably met a lot of really smart people. And others. In your experience, who's done better financially? The smart people you know, or the.... others? Is there even any correlation an investor's IQ points and her investment performance?

The fundamental problem I'm seeing with labels like "dumb money" and "smart money" is that they have nothing to do with actual investment performance (let alone intellect). Take me, for example. Even though I proudly classify myself as a member of the "not exactly dumb" money club, I assure you that have done (and probably continue to do) plenty of remarkably dumb stuff with money. My only saving grace is that I hedge myself (having discovered that it is hard to do dumb stuff if I don't do stuff, period).

You wouldn't think it, just by looking at me, but I'll admit it. I'm vain. I resist the invitation to join the "dumb money" folks even though I know that if I did succumb and doff the dumb money propeller beanie, I would be far better off, financially. For one thing, I would be disinclined to buy a stock simply because someone spiffy looking on CNBC is telling me that the "dumb money" people are selling it. It all comes down to branding and ego. It wouldn't be so bad if you called it "oblivious" money, or even primped it up with a bit more flourish like "maybe-not-the-most-informed" money. Has a nice ring to it, in fact. And as an added bonus, it sounds all matchy matchy with that most timeless of classic looks: superior investment returns.

Take my kid, for example. He is a teenager now, but when he launched his investment career at the age of just under four years old, he fit squarely into the "maybe-not-the-most-informed" money club. Back then, I got it into my head that he could learn everything that he needed to know about investing his money with just a little experience, so I took him to McDonald's (MCD). We ate some fries and watched people standing in line buying things, and I asked "where do you think all that money goes?" He didn't know, so I explained "so you know how those Legos belong to you and not to anyone else?" He did. "Well, this restaurant belongs to some people. They are called stockholders. They own all the McDonald's restaurants that exist." None of this was interesting to my kid at all, until I pointed out "and you can be one of the stockholders too! You just buy some stock, and then every McDonald's restaurant in the world is yours - but you have to share with the other stockholders."

My kid decided that sounded pretty good, and so when I asked him whether he'd like to buy some stock in McDonald's, he said he did. I told him that he had to explain to me why he wanted it, and he said it was because a lot of people were paying money up at the counter. "Great reason", I said. Later that afternoon, my very young investor bought his first shares of MCD.

I decided to let him pick a few other companies to buy with his savings, too. Over a period of a few days, he selected three more companies that he saw every day. Starbucks (SBUX), Whole Foods (now (AMZN)) and a boutique soft drink maker called Reeds (REED). These were not random choices. He liked to drink Reeds. He thought there were a lot of people paying money at Whole Foods and Starbucks. He especially liked those cake lollipops that Starbucks used to sell for something like $3.75 apiece.

My plan was to teach my kid from a wildly early age how to be sane with money, and to use these four investments that he picked for himself as a springboard for lessons on investing and finance. I had mixed results, to be honest. Try as I might, I really could not get him to sit still for more than 30 seconds if I started to talk about things like PE ratios or earnings. His patience has improved over the years, but watch his investments like a hawk, he does not. He absolutely qualifies as "maybe-not-the-most-informed" money.

And how about his average annual rate of return on the four investments that he considered, ultimately selected and then proceeded to rarely bother with? Using the DRIP calculator on DividendChannel.com (Cool Dividend Calculator), I see that the WFM investment produced 9.38% a year (he DRIPs dividends), MCD comes in at 14.26% a year, SBUX is 20.8% per year and REEDs is -7.68% per year. Averaged out, that's a 12.25% return per year over the last decade and a half.

My "maybe-not-the-most-informed" investor outperforms the S&P 500 by almost 4.5% a year. When he's not too busy sassing his mother, or playing video games while he pretends to do his homework.

I think it's fair to assume that if you asked shareholders of Sears, they'd happily exchange Eddie Lampert's "smart money" performance for "maybe-not-the-most-informed" performance (with 51.27% higher annual performance over a 10.81 year period).

I know. Some folks are going to just chalk it up to luck. After all, it's easy to cheapen the performance of 4-year olds and other "maybe-not-the-most-informed" money crowd - especially when they are making a lot more money than you are. In fact, maybe this is exactly where the expression "dumb money" came from? Could it be hardworking, disgruntled investors on CNBC who don't earn as much money as "less-than-the-most-informed" investors?

But what I am telling you is that it wasn't luck. It was choice. The kid picked what he was familiar with, he thought about lines of people at the store paying money, he thought about buying products that he probably wanted his dad to buy him, and then never had a reason to pay much more attention than that.

But it's what he didn't pay attention to that is the most important lesson of all - to me, at least. My kid literally paid (and continues to pay) zero attention to what other shareholders are doing. He does not know or care who those other shareholders might be, or whether they are more knowledgeable than he is. He cares about precisely one thing: is it a good business, and does he personally want to own it. And it has worked out for him far better than vanity or ego have worked for me.

Disclosure: I am/we are long MCD, SBUX, REED. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not investment advice and I am not an investment advisor. Nothing in this article can be relied upon by any person for any reason other than entertainment value.